EPAct 179D Experts

"The least expensive kilowatt, is the one not used."

- Jacob Goldman

The Energy Tax Aspects of Chillers

Chillers are one of the more expensive building equipment items, ranging
from tens of thousands of dollars to millions of dollars at large facilities.
Chillers are industrial refrigerating systems that are an integral part of
commercial HVAC systems. They are most frequently utilized in office buildings,
industrial buildings, hotels, hospitals, apartment buildings and other large
buildings. Due to the high cost of chillers, many companies deferred chiller
purchases during the recent economic downturn. As a result of EPAct, these
companies should carefully consider their chiller tax planning opportunities
and act before the December 2013 EPAct expiration date on EPAct eligible
chiller projects. There are multiple opportunities, including EPAct, for
favorable tax treatment depending on whether the chiller is being purchased for
a new building or an existing building, and the type of building. A smart tax
planning decision can only be made after analyzing each tax deduction
opportunity.

The Tax Deduction Opportunities

The EPAct 179D Tax Deduction

Pursuant to Energy Policy Act (EPAct) Section 179D, building owners or
tenants making qualifying energy-reducing investments can obtain immediate tax
deductions of up to $1.80 per square foot.

If the building project doesn't qualify for the maximum $1.80 per square
foot immediate tax deduction, there are tax deductions of up to $0.60 per
square foot for each of the three major building subsystems: lighting, HVAC
(heating, ventilating, and air conditioning), and the building envelope. The
building envelope is every item on the building’s exterior perimeter that
touches the outside world including roof, walls, insulation, doors, windows and
foundation.

The Business Expense Deduction

Pursuant to Internal Revenue Code Section 162, a building owner or tenant
can deduct all ordinary and necessary expenses paid or incurred during the
taxable year in carrying on their business. It is important to note that the
chiller repair expense is only available if the chiller project meets multiple
tests all of which need be documented. For example the fact that the old unit
has completed its life cycle and energy performance values, should be supported
by quantitative metrics. Also, the property repair expense cannot be claimed
for a capital improvement that substantially adds to the value or useful life
of a building. Capital improvements are depreciated as building assets under
normal building tax depreciation rules. In determining the difference between
an ordinary business expense and a capital improvement there has always been a
line based on facts and circumstances; however, the court in FedEx Corp. v.
United States set out a useful criteria in making this decision, which are:

The industry custom,

A comparison of the economic useful lives of the
part and the whole,

Whether the larger and smaller units of property
can function without each other, and

Whether maintenance on the smaller property can
occur while affixed to the larger property .

For larger buildings, in order to obtain the maximum HVAC EPAct deduction
while installing a chiller, the owner needs to combine the chiller with an
efficient HVAC system. An example of this is a thermal storage system, which
when installed with a new high efficiency chiller and package unit will often
reduce energy cost to where the maximum EPAct HVAC deduction is a possibility,
particularly in jurisdictions with time of day electricity pricing differences
. Large EPAct deductions are also typically available for an apartment building
that installs a chiller because the energy standards for apartment buildings
are based on devices that are less efficient than chillers .

A building less than 150,000 square feet is the typical building where a
chiller can be installed on its own, reduce energy use below the required
levels, and thus trigger immediate EPAct HVAC tax deductions. Chillers can also
be powered in ways other than by electrical energy. These hybrid fuel chillers
use other forms of energy, such as natural gas or low-grade waste heat, and in
the right situation can reduce energy cost more so than an electric chiller.

A final opportunity for large HVAC EPAct tax deductions from installation of
a chiller is for a central chiller plant that serves multiple buildings less
than 150,000 square feet. In this situation every building supported by the
central chiller plant can be in line for large HVAC tax savings.

The $0.60 per square foot maximum HVAC deduction is achieved when total
building energy use is reduced by 16.67% or more . The following chart shows
the possible immediate EPAct tax deductions at various square footages for a
new building:

To obtain the $0.60 to $1.80 per square foot EPAct tax deductions, the
required energy cost reduction must be documented by an IRS approved energy
simulation model. The ever popular United States Green Building Council’s
Leadership in Energy and Environmental Design (USGBC’s LEED)
certification program also requires building energy modeling. Moreover,
recognizing the increasing importance of building energy efficiency measures,
the recently revamped LEED system places much more emphasis on granting LEED
qualifying points for energy efficiency measures. The only way to accurately
right size HVAC to the building envelope and other building systems is to model
the building. As a result of improvements in CAD systems and modeling
interfaces, along with the huge increase in professionally trained software
modelers, soon every new building will be modeled as matter of course .

Existing Buildings

Existing building chiller projects may be eligible for the $1.80 179D
immediate tax deduction described above or a properly documented unit of
property repair expense deduction. A smaller building will want to choose the
property repair expense deduction, because chillers are typically very
expensive, and that deduction is not based on the square footage of the
building, whereas the EPAct deduction is. An example of this is a 140,000
square foot building that installs a $300,000 chiller. The $0.60/sq.ft. EPAct
HVAC tax deduction would be $84,000, but the repair expense deduction would be
$300,000.

However, in many situations where the existing building chiller installation
would qualify for the EPAct deduction, the installation would probably arise to
a capital improvement and thus would not be eligible for the property repair
expense deduction. The most common chiller replacement where repair expense is
applicable will be a so called one-for-one similar kind of chiller replacement.
It is crucial to have a chiller study thoroughly documenting repair expense
eligibility since the IRS is going to start with a presumption that the chiller
should be capitalized. A good chiller tax study should incorporate about 10
documentation factors that make it easy for the auditor to verify repair
expense eligibility. The chiller study should be prepared by tax experts
intimately familiar with building energy and chiller technology . If a building
energy simulation model exists and the EPAct and repair expense deduction
amounts are similar it may make sense to use the model as documentation rather
than expending the effort required for a separate study.

If a chiller project qualifies for either tax deduction but the taxpayer is
contemplating a future investment that will only qualify for EPAct, then it
would make more sense to first use the repair expense tax deduction. This is
evidenced by the following example: Presume the taxpayer replaces an existing
chiller on a 120,000 square foot building at cost net of rebate for $72,000 and
is eligible for either a $72,000 EPAct tax deduction (120,000 x $0.60/sq.ft.)
or a $72,000 repair expense deduction. If the same taxpayer is contemplating an
LED lighting project by 2013 it may make more sense to first select the $72,000
repair expense and potentially obtain a $1.80 per square foot EPAct deduction
upon the completion of the future LED project. With this approach the taxpayer
has maximized the universe of tax opportunities.

Conclusion

Chillers are very expensive building equipment items; however, installing
them presents large tax deduction opportunities. When advising on tax planning
for a chiller deduction, it is important to look at the type of building, and
whether it is an existing building being retrofitted or if the building is new.
It is also important to take potential future energy efficiency projects into
account when making the decision of which deduction to take. As seen above, if
the correct decisions are made, the tax savings can be quite large.